Asian institutions building out internal investment capabilities

Asian institutions’ appetite for external asset management is growing slowly with the recovery in global markets, but new research from Greenwich Associates reveals that many institutions across Asia are making a longer-term commitment to managing assets in-house.

These conclusions are drawn from the results of Greenwich Associates’ 2010 Asian Investment Management Study, in which 84 of the largest institutional investors in Hong Kong, Macau, China, Taiwan, South Korea, Singapore and other Asian countries were interviewed.

The institutions participating in the study together manage some USD5trn in assets, a sum that was roughly unchanged from 2009 to 2010.

Because central banks and large government-affiliated institutions included in the research group manage most assets in-house, only 12 per cent of these total assets are accessible to external investment managers.

Although that share could increase slightly in the near term from the rock-bottom levels reached during and right after the global crisis, many Asian institutions have made a secular decision to emphasise internal management over a longer horizon.

Forty per cent of institutions say they expect to increase the amount of onshore assets allocated to external managers over the next year. However, 30 per cent of Asian institutions say the performance of external managers during the market crisis has caused them to alter long-term plans in favour of internal management, with only three per cent reporting long-term plans to increase their use of external managers.

To that end, almost two-thirds of Asian institutions plan to significantly increase their internal management expertise and capabilities in the coming year.

“In western markets, institutions that manage significant assets in-house generally focus their resources on passive strategies,” says Greenwich Associates consultant Markus Ohlig. “But two-thirds of Asian institutions are using their internal teams to generate alpha, in cases running portfolios in parallel to those of external managers as a means of learning and developing better skills in specific asset classes.”

Generally, the consultants at Greenwich Associates urge institutions to use caution when considering a build-out of internal investment capabilities. For some Asian institutions, in-house management is probably a solid option for certain asset classes.

However, the move to internal management by large numbers of Asia’s smaller institutions could be cause for concern. Seventy per cent of Asian institutions with assets over USD5bn say they expect to significantly expand their internal management capabilities in the next year, as do 60 per cent of institutions with less than USD5bn.

These institutions should look first to the experiences of other institutions around the world that have tried to move in that direction. There are ample examples of institutions — especially in Europe — that committed significant resources to building internal management capabilities only to find out later that they had severely underestimated the challenges associated with active management.

Among the issues frequently given short-thrift are the infrastructure elements required to maintain a disciplined investment process, including compliance, trading cost analysis, counterparty risk management, and other items, as well as the costs of attracting and maintaining talented investment and trading professionals.

“Although it might not seem so at the outset, when an institution decides to build out its internal investment capabilities, it is entering into direct competition with external managers,” says Greenwich Associates consultant Abhi Shroff. “The only way to build a high quality team is to pay portfolio managers, analysts and traders salaries comparable to those offered by dedicated investment management firms. For some public funds and small institutions, that is just never going to be an achievable goal.”

In 2010, RCM, Wellington Management and Pimco are the Greenwich Leaders in overall franchise quality. Pimco and Blackrock (Barclays Global Investors) are the most widely used investment managers among Asian institutions.